Having previously outlined different perspectives on a “best interest” standard of care, Fred Reish now looks at how that standard applies to specific circumstances.
In a recent blog post, Reish notes that there are three parts to any best interest standard: that there be a process involved in the recommendation measured by an objective standard, that the advisor act with loyalty to the investor, and that the recommendation appropriately consider the needs and circumstances of the investor.
He then turns to the SEC’s proposed Regulation Best Interest (Reg BI) and its best interest standard for broker-dealers, which Reish says elevates (as compared to the suitability standard) the importance of costs – an emphasis he finds to be consistent with the fiduciary standard in ERISA’s prudent man rule, and also consistent with the fiduciary standard for registered investment advisers.
“In other words,” he writes, “the new best interest ‘world’ is placing greater emphasis on costs as a ‘relevant’ factor for determining whether a recommendation satisfies that standard,” though he cautions that the requirement is that costs “must be objectively and prudently considered (and given appropriate weight).”
Applied to mutual funds, Reish points out that that standard means that advisors need to make sure that the expense ratios of recommended mutual funds are reasonable, which he says would generally require that an advisor recommend the lowest-cost share class of a mutual fund that is available to the advisor and the investor.
He cautions that depending on the circumstances, that could mean a particular share class for one investor, but a different share class of the same mutual fund for another investor, going on to cite an example of a retail investor with a long-term investment horizon for whom it might be cheaper to use A shares with a front end load rather than C shares.
Reish concludes that the appropriate focus is a “careful consideration of costs, considering the alternatives, based on an investor’s needs, circumstances, investment horizon and other relevant factors.”